The Obama administration, in its latest bid to prevent American companies from minimizing U.S. taxes by rebasing abroad, issued final rules on Thursday to combat a key tax-reduction technique known as earnings stripping.
Six months after proposing the regulations, the U.S. Treasury made good on its pledge to move swiftly against corporate tax inversions by rolling out the new final rule, despite opposition from business groups and from Republicans in Congress who demanded a delay only last week.
“For years, this administration consistently has called for comprehensive business tax reform to fix our broken tax system,” Treasury Secretary Jack Lew told reporters. “In the absence of congressional action, however, it is Treasury’s responsibility to use our authority to protect the tax base.”
Business lobbyists said the rules would likely be challenged in court.
Tax inversions occur when a U.S. company is acquired by a smaller foreign business from a low-tax country and adopts its domicile to reduce the combined firm’s overall U.S. tax burden.
Inversions have occurred since the 1980s, but a new wave in recent years prompted the Treasury to take a series of actions including Thursday’s final regulations, which were unveiled in April as part of a package that led to the collapse of a $160 billion merger deal between U.S. drugmaker Pfizer Inc and Ireland’s Allergan Plc.
Treasury also imposed a temporary rule in April to prevent foreign companies from engaging in serial inversions. That is expected to be finalized later this year.
Earnings stripping occurs when the U.S. subsidiary of a newly inverted company avoids taxes on domestic operations by sending them overseas as tax-deductable interest payments.
The newly finalized regulations would reclassify some forms of debt as equity, changing tax-exempt interest payments into dividends that are taxed.
Business groups including the U.S. Chamber of Commerce have warned that the regulations could harm the cash management operations of U.S.-based multinationals and pose damaging unintended consequences for a range of businesses by creating mountains of red tape.
But Treasury officials said the final rules addressed those concerns by granting exemptions for regulated financial and insurance firms, cash pooling, short-term debt, transactions between the foreign units of U.S. companies, stock acquisitions for employee compensation plans and other operations.
The regulation also relaxed requirements for companies to document intercompany loans and delayed the documentation deadline for a year to Jan. 1, 2018.